February 14, 2014

Report: The Role of Investors in the One-to-Three-Family REO Market: The Case of Cleveland

A team of local researchers, including the Center on Urban Poverty and Community Development, Thriving Communities Institute, Poverty Center Affiliated Faculty Member Robin Dubin, and others, have released a report on the effects of investor-ownership on foreclosed properties, convened by the Joint Center for Housing Studies at Harvard University and the What Works Collaborative.

The report, The Role of Investors in the One-to-Three-Family REO Market: The Case of Cleveland, shows that nearly one out of every three Cleveland homes sold by banks after mortgage foreclosures end up condemned, abandoned, boarded up or demolished. Hazard-rate analysis shows that the failure rate for these transactions is five times higher for larger investors and out-of-state buyers than for small investors. Properties that ended up in the hands of land banks, community development corporations and governments, when compared to small investors, were three times more likely to succeed.

The study is the first to take a long-term look at the impact of foreclosure in Cuyahoga County. "We analyzed data from more than 73,000 post-foreclosure transactions in the County between 2000 and 2012," stated April Hirsh, Research Assistant at Poverty Center. The study found that the manner in which foreclosed houses were disposed and traded compounded the problem of blighted homes, resulting in $46 million in uncollected property taxes and creating a "disproportionately negative impact" on African-American neighborhoods.

The study also found that while it will cost $83 million to demolish Cleveland's approximately 8,300 condemned houses, traditional renovation approaches would require even greater subsidization with tax dollars. Other less inclusive approaches to renovation, such as only bringing the property up to code, can require less subsidy than demolition in most neighborhoods in the short run, but, as the study points out this alternative "offers little extended life to the structure and thus the structure could be at risk of future disrepair".

Lead author Frank Ford, senior policy adviser for Western Reserve Land Conservancy's Thriving Communities Institute and chairman of the Cleveland Vacant and Abandoned Properties Council, said the study sought to understand the business practices of those investing in mortgage-foreclosed homes so regulators could act to discourage irresponsible practices and identify cost-effective means of renovation.

To find out more about investor impact, Professor Robin Dubin, PhD., of the Weatherhead School of Management at Case Western Reserve University, used Hazard Rate Analysis to determine whether the size of the investor affected the success or failure of a property. Using this method the study found significant differences among investor types. "By 2008, properties purchased by out-of-state large investors were almost five times as likely to fail as those purchased by small investors," stated Professor Dubin.

Ford said the study shows aggressive code enforcement works and has chased bad actors out of Ohio. Meanwhile, responsible investors have found that traditional bank financing has been difficult or impossible to obtain for inner city home renovation.

The study found that traditional renovation approaches are no longer financially viable in most distressed Cleveland neighborhoods, and, until market conditions improve, demolition will likely be the most viable tool for market recovery. "A Catch-22 dilemma exists: In distressed neighborhoods blighted homes can't be renovated until the market improves, but the market can't improve until blighted homes are removed," explained Ford. The only viable alternative to demolition in more distressed neighborhoods is minimal rehabilitation that does not provide long-term sustainability for the home.

The study was conducted by Ford, who joined Thriving Communities in 2013; April Hirsh of the Jack, Joseph and Morton Mandel School of Applied Social Sciences at Case Western Reserve University; Kathryn Clover, J.D. of Cleveland Marshall College of Law, Cleveland State University; Jeffrey A. Marks of Marks Housing Consultants, LLC; Robin Dubin, Ph. D. of Case's Weatherhead School of Management; Michael Schramm of Case's Mandel School of Applied Social Sciences and the Cuyahoga County Land Reutilization Corporation; and Tsui Chan, Nina Lalich, Andrew Loucky and Natalia Cabrera of Case.

In addition to support from Harvard University, local support for the study was provided by Cleveland Neighborhood Progress and the Thriving Communities Institute.

On February 10, WCPN Ideastream discussed this report. A few days later on February 14, also covered this report (subscription required).